One of the first decisions you will need to make when starting your business is what business structure your business will take.
Hopefully, if you have reached this stage, you understand that forming a corporate entity is a necessary part of starting your own business. Whether you are a tech startup or a blogger, this is just something you need to do and put it behind you.
So which business structures should you be thinking about utilizing? At first glance, this choice may be overwhelming if you have never started a business before. But what you will soon see is that many of the options are not appropriate for you, and the choice, for most startups, comes down to an LLC (Limited Liability Company) or an S-Corporation.
If you haven’t already downloaded our business selection cheat sheet, click here to do so now.
The Most Common Business Structures
The most common business structures are the sole proprietorship, the partnership, the C and S-Corporations, and the LLC. We’ll take these one at a time.
A sole proprietorship is the default business structure. In reality, it is no structure at all. You are basically operating your business under your personal name. By doing this, you have no protection from the liabilities of your business, and the business is not protected from your personal liabilities. Is it simple and cheap to do? Yes, as the only filing fees you will have to pay are the requisite business licenses or fees where you live, or perhaps requesting a DBA (doing business as) from your state.
A partnership is basically a sole proprietorship with more than one person. So if two or more (non-spouse) individuals are running a business together, it is a partnership. In the absence of a partnership agreement, the rights and duties of the partners would be spelled out by state law. This includes formation, ownership of partnership assets, fiduciary duties, settling of disputes between partners, and termination of the partnership.
The partnership does not pay taxes directly, the income of the partnership would flow through to the individual partners. Like a sole proprietorship, you don’t have to do anything special to start a partnership except getting the requisite licenses from your city or county.
Corporation (aka C-Corp)
A corporation is a much more complex business entity than anything mentioned so far. To form a corporation, you have to file a document called the “Articles of Incorporation” with the Secretary of State in the state where you choose to form your corporation. A corporation is a legal entity separate and distinct from the owners of the corporation, also called stockholders or shareholders.
The main benefits of a corporation are that it provides for limited liability of the stockholder and that it allows the business owner to seek outside investors by selling stock. However, it is also more expensive to start-up and maintain, and to preserve the limited liability, the corporation must adhere to strict formalities and regulations. In addition, a corporation will pay its own taxes.
Subchapter S Corporation (aka S-Corp)
The biggest difference between an S Corp and a C Corp is the tax treatment of the entity. Whereas the C Corp will file and pay its own taxes, an S Corp will allow the owner to pass-through the income of the corporation to the owner’s personal tax return. In addition, S Corps are limited to 100 shareholders.
Limited Liability Company (LLC)
A limited liability company is a great option for a small business that will not be seeking capital contributions but wants to retain the limited liability protection afforded to corporations. An LLC has a flexible management structure and does not have all the rigid corporate formalities of a corporation.
An LLC can be taxed as either a sole proprietorship or it can elect S-Corp status for tax purposes.
One of the main benefits of LLC’s is that it also provides charging order protection for the owner of the LLC. This means that if the owner gets sued personally, the judgment creditor cannot come after the assets of the LLC. However, this level of protection varies by state.
One of the drawbacks of the LLC is that the filing and annual reporting fees can sometimes be hefty as compared to the fees for a Corporation.
Other Less Common Business Structures
There are two other business structures you can choose from, but they are reserved for special situations. They are the NonProfit Corporation and the Professional Service Corporation.
If you are looking to start a business that has charitable goals, then you can start a non-profit corporation. However, you must be aware that a non-profit is required to have a board of directors to oversee the business. Nonprofits do not pay a tax on profits of the business.
Professional Service Corporations
If you are a doctor, lawyer, chiropractor, accountant, or another type of professional service provider, you may form a professional service corporation. All of the shareholders of this corporation must hold a professional license.